Central bankers write requiem for inflation strategies

That was a key message from the president of the United States Federal Reserve, Jerome Powelland their European counterparts on Wednesday as they debated how to tackle persistent price pressures and slower growth.

“I don’t think we’re going to go back to that low-inflation environment”said the president of the European Central Bank, Christine Lagardeat the annual ECB forum in Sintra, Portugal.

“There are forces that have been unleashed as a result of the pandemic, as a result of this enormous geopolitical crisis that we are facing now, that are going to change the image and the landscape in which we operate”he said during a 90-minute panel discussion moderated by Francine Laquafrom Bloomberg Television.

His comments, along with those of Powell and the governor of the Bank of England, Andrew Bailey, signify a possible change in the practice of monetary policy. For years, the main enemy central bankers faced was inflation that was too low, leading them to implement near-zero interest rates and huge bond purchases to propel their economies through recessions and weak recoveries.

The common enemy now is strong price pressures, which have risen to 40-year highs in the United States as supply chains entangled by the pandemic and the Russian invasion of Ukraine Predictions that they will be fleeting sink, forcing central bankers to slam on the brakes: The Fed raised interest rates by 75 basis points this month, the biggest increase since 1994, and signaled it might do the same in July.

For Powell and his colleagues, if core inflation is found to be at risk of rising and uprooting from the Fed’s 2% target, that could mean an even more aggressive policy shift than their June forecast suggests.

That outlook, already showing the Fed’s most hawkish move since the 1990s, projects rates will rise another 175 basis points this year and peak between 3.75% and 4% in 2023. Next week, officials point to modest rate cuts as growth moderates and inflation returns to target.

The head of the Fed warned of a “redivision of the world into rival geopolitical and economic camps, and a reversal of globalization” which could result in lower productivity and growth.

The risk of longer-lasting scarcity can already be seen as the world rearranges itself. Inflation rates in the United States, the United Kingdom and the eurozone are well above their targets and the concern is that this could persist as global production and trade patterns are reconfigured.

For decades, advanced economies have enjoyed the benefits of globalization. In central banking terminology, inflation expectations were anchored and that made it possible for central banks to allow labor markets to work better. Access to foreign labor also hurt workers’ bargaining power, further undermining inflation, but at a social cost as wages stagnated.

“The last ten years were so far the height of the disinflationary forces we face”Powell said. “That world seems to have disappeared now, at least for the time being. Now we live with different forces and we have to think about monetary policy in a very different way”.

“We are committed and we will get inflation down to 2%”Powell said. “It is very likely that the process involves certain complications, but the worst complication would arise as a consequence of not addressing this high inflation and allowing it to become persistent”.